Discover more from TKer by Sam Ro
The end of the inflation crisis 🎈
Plus a charted review of the macro crosscurrents 🔀
📆 TKer will be off next Sunday. The free weekly newsletter will return on Sunday, Dec. 3. Happy Thanksgiving!
Stocks rallied last week, with the S&P 500 climbing 2.2% to close at 4,514.02. The index is now up 17.6% year to date, up 26.2% from its October 12, 2022 closing low of 3,577.03, and down 5.9% from its January 3, 2022 record closing high of 4,796.56.
Here’s some good news: Thanksgiving dinner has become less pricey.
According to the American Farm Bureau, the average cost of a Thanksgiving dinner for 10 costs $61.17 this year, down 4.5% from last year.
“The centerpiece on most Thanksgiving tables — the turkey — helped bring down the overall cost of dinner,” the Farm Bureau observed. “The average price for a 16-pound turkey is $27.35. That is $1.71 per pound, down 5.6% from last year.“
It’s the latest encouraging development in the Federal Reserve’s long fight to bring inflation down.
While prices for most goods and services aren’t deflating as they are for turkeys, the inflation rates have certainly eased. And, importantly, concerns about prices are receding.
Signs the inflation crisis is over 👍
According to BLS data released Tuesday, the Consumer Price Index (CPI) in October was up 3.2% from a year ago. Adjusted for food and energy prices, core CPI was up 4.0%, the lowest since September 2021.
On a month-over-month basis, CPI was unchanged as energy prices fell 2.5%. Core CPI was up a modest 0.2%. If you annualize the three-month trend in the monthly figures, CPI was rising at a 4.4% rate and core CPI was climbing at a 3.4% rate.
While many broad measures of inflation continue to hover above the Fed’s target rate of 2%, they are way down from peak levels in the summer of 2022. And the trend suggests they could continue to move lower.
Among the most visible price categories is gasoline, which many consumers confront regularly. And it’s been cooling.
“With Thanksgiving fast approaching (and maybe the in-laws), the national average for a gallon of gas is steadily declining,” AAA observed on Thursday. “Since last week, pump prices have fallen six cents to $3.34. Since the price peak for 2023, the national average has either fallen or remained flat for 60 straight days.”
This comes as oil prices tumbled by more than 20% from their recent highs.
Indeed, consumers confirm they have taken notice of recent price trends.
From the New York Fed’s October Survey of Consumer Expectations: “Median inflation expectations declined at the one-year and five-year ahead horizons in October, falling to 3.6% from 3.7% and to 2.7% from 2.8%, respectively. Median inflation expectations at the three-year ahead horizon remained unchanged at 3.0%.“
This is a marked improvement from June 2022, when consumers were looking for 6.8% inflation in the year ahead.
Corporate executives have also taken notice.
According to Bloomberg’s Michael McDonough, the number of discussions on inflation in S&P 500 earnings calls has been trending lower for more than a year.
Financial market professionals are also a little less worried about inflation.
According to Bank of America’s Global Fund Manager Survey, inflation had been identified as the “biggest tail risk” almost every month since March 2021. But according to the October survey released on Tuesday, it was replaced by geopolitics.
Another indicator: Wholesale prices actually contracted in October, with the Producer Price Index falling 0.5% month over month in October.
‘The hard part is over’ 👀
In a research note laying out their 2024 outlook for the U.S. economy, Goldman Sachs economists declared: “The hard part is over.”
“More disinflation is in store over the next year,” the economists wrote. “Although the normalization in product and labor markets is now well advanced, its full disinflationary effect is still playing out, and core inflation should fall back to 2-2½% by end-2024.“
While discussing Walmart’s financial results, Walmart’s CEO Doug McMillion even said: "In the U.S., we may be managing through a period of deflation in the months to come. And while that would put more unit pressure on us, we welcome it because it's better for our customers."
Sure, policymakers and most other folks still want overall inflation rates to come down a bit more. And in this process — and after this process — inflation will continue to represent a source of risk and uncertainty.
But I think we can probably say the crisis is over.
The ‘Goldilocks’ soft landing 👱♀️
I have no doubt that people will continue to complain about prices levels. After all, low inflation just means prices will rise from current levels but just at a moderate rate. (If you want prices to outright fall, you’re talking about deflation, which is a whole other scary beast.)
And just as in boom times and in busts, there will continue to be people struggling with costs.
But at the macroeconomic level, the confluence of price data seems to increasingly support the idea that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This narrative — which TKer has been advancing weekly since the beginning of the year — has even taken on renewed interest in the big business news outlets. Some headlines via CNBC’s Carl Quintanilla:
This is not to say the economy has a totally clear path ahead of it. Indeed, there are some warning signs emerging suggesting there could be more slowing ahead.
But for now, I think we can close the book on the inflation crisis we’ve been talking about for the last two years.
Related from TKer:
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🎈 Inflation cools. We got a lot of data on inflation in the past week. You can see it all above.
🛍️ Spending cools from record levels. Retail sales ticked lower from record levels, declining 0.1% in October to $705.0 billion. It’s worth noting that September’s initial print of $697.6 billion was revised up to $705.7 billion.
From Wells Fargo: “Consumer spending may be losing a bit of momentum, but not as much as had been widely expected given the recent deterioration in various measures of consumer sentiment.“
For more on consumer strength, read: People have money 💵
⚠️ Mixed signals from the major retailers. Big box retailers Walmart and Target announced their quarterly results.
Here’s Bloomberg on Walmart: “Walmart Inc. modestly raised its annual profit forecast but struck a cautious tone about the outlook for US shoppers after signs of weakness at the end of October. There was a ‘sharper falloff’ in sales during the last two weeks of October, Chief Financial Officer John David Rainey said in an interview Thursday as Walmart reported financial results. Demand picked up in November, spurred in part by seasonal offerings.“
Here’s CNBC on Target: “Target on Wednesday topped Wall Street’s quarterly sales expectations and blew past earnings estimates, as purchases in high-frequency categories like food and beauty helped prop up weaker customer spending… Yet the big-box retailer stared down the same challenges that it has faced over the past year. Shoppers aren’t buying much more than the necessities. They’re hungry for lower prices. And when they do make purchases, they’re postponing them – such as waiting until the temperature drops to buy a pair of jeans or a sweatshirt, CEO Brian Cornell said on a call with reporters.“
For more on the cooling consumer, read: Be mindful of the warning signs ⚠️
💳 Spending is holding up, according to credit card data. From BofA: “Total card spending per HH was up 0.7% y/y in the week ending Nov 11, according to BAC aggregated credit and debit card data. Total spending per HH ex gas increased 1.4% y/y, while retail ex autos was down 1.1% y/y in the week ending Nov 11. Relative to October, y/y spending trends have improved modestly in November so far.“
For more on household finances, read: People have money 💵
💼 Unemployment claims rise. Initial claims for unemployment benefits increased to 231,000 during the week ending November 11, up from 217,000 the week prior. While this is up from a September 2022 low of 182,000, it continues to trend at levels associated with economic growth.
For more on the labor market, read: The hot but cooling labor market in 16 charts 📊🔥🧊
🚗 New cars are becoming more affordable. From Cox Automotive: “Income growth favored consumers enough in October to offset the impact of higher prices, lower incentives, and higher auto loan rates. New-vehicle affordability improved slightly month over month and year over year, according to the Cox Automotive/Moody’s Analytics Vehicle Affordability Index. … The typical payment increased by 0.2%, but the number of median weeks of income needed to purchase the average new vehicle declined to 38.6 weeks from a downwardly revised 38.7 weeks in September. At 38.6, it was lower than the 40.1 weeks recorded last October.“
🚗 Used car prices are coming down. From Manheim: “Wholesale used-vehicle prices (on a mix-, mileage-, and seasonally adjusted basis) decreased 1.6% from October in the first 15 days of November. The mid-month Manheim Used Vehicle Value Index declined to 206.1, which was down 5.3% from the full month of November 2022.“
📈 Mortgage rates decline. According to Freddie Mac, the average 30-year fixed-rate mortgage fell to 7.44%. From Freddie Mac: “For the third straight week, mortgage rates trended down, as new data indicates that inflationary pressures are receding. The combination of continued economic strength, lower inflation and lower mortgage rates should likely bring more potential homebuyers into the market.”
🏡 Many own their homes outright. From Bloomberg: “There’s talk of a great divide in the U.S. housing market, as new buyers get crushed by 8% mortgage rates while earlier ones cling gratefully to loans of less than 3%. Missing from this story is a third, even more fortunate group: the rapidly growing number of Americans who own their homes outright. The share of US homes that are mortgage-free jumped 5 percentage points from 2012 to 2022, to a record just shy of 40%.“
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
🔨 New home construction ticks up. Housing starts rose 1.9% in October to an annualized rate of 1.37 million units, according to the Census Bureau. Building permits climbed 1.1% to an annualized rate of 1.49 million units.
🏠 Home builder sentiment is in the dumps. From the NAHB’s Alicia Huey: “The rise in interest rates since the end of August has dampened builder views of market conditions, as a large number of prospective buyers were priced out of the market. … Moreover, higher short-term interest rates have increased the cost of financing for home builders and land developers, adding another headwind for housing supply in a market low on resale inventory.”
For more on housing, read: The U.S. housing market has gone cold 🥶
🏢 Offices are still very empty. From Kastle Systems: “Office occupancy hit a new pandemic record high last week. Kastle’s 10-city Back to Work Barometer rose nine tenths of a point to 50.5%, surpassing September’s record high of 50.4% occupancy. The rise was led by Chicago, which rose three full points to 55%, and San Francisco, which rose 2.1 points to 44% occupancy. New York City rose 1.6 points to 50.5% occupancy, matching its previous pandemic high in June.“
For more on office occupancy, read: This stat about offices reminds us things are far from normal 🏢
💰 Small business finances are healthy. From BofA: “…small business net worth has surged during the last few years, meaning that even with the rise in credit card debt, the ratio of debt to net worth remains at historically low levels. This can be seen in Exhibit 3, which shows the ratio between total bank loans, including credit card loans, and net worth for nonfinancial noncorporate businesses - most of which are small businesses.“
For more on business finances, read: Why higher interest rates haven't crushed corporate profits 🤔
📉 Small business optimism ticks lower. The NFIB’s Small Business Optimism Index ticked lower in October.
Importantly, the more tangible “hard” components of the index continue to hold up much better than the more sentiment-oriented “soft” components.
Keep in mind that during times of stress, soft data tends to be more exaggerated than actual hard data.
For more on this, read: What businesses do > what businesses say 🙊
🍾 The entrepreneurial spirit is alive. Monthly small business applications remain well above prepandemic levels. From the Census Bureau: “October 2023 Business Applications were 472,993, virtually unchanged (seasonally adjusted) from September. Of those, 154,153 were High-Propensity Business Applications.“
🛠️ Industrial activity slips. Industrial production activity in October fell 0.4% from September levels, with manufacturing output falling 0.7%.
From JPMorgan: “The October drop in activity should be viewed as largely temporary, as strikes helped push motor vehicle and parts output down 10.0% during the month. That said, things weren't great away from the auto sector, with output for manufacturing ex. motor vehicles and parts up only a modest 0.1%.“
📈 Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.1% rate in Q4.
For more on the forces bolstering economic growth, read: 9 reasons to be optimistic about the economy and markets 💪
Putting it all together 🤔
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to bring inflation down. While it’s true that the Fed has taken a less hawkish tone in 2023 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened or is near, inflation still has to cool more and stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 during the first half of 2023. As you stretch the time horizon, the numbers get more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 85.6% underperformed. And over a 20-year period, 93.6% underperformed.
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 318 large-cap equity funds were in the top half of performance in 2020. Of those funds, 39% came in the top half again in 2021, and just 5% were able to extend that streak through 2022. If you set the bar even higher and consider those in the top quartile of performance, just 7% of 156 large-cap funds remained in the top quartile in 2021. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2022.
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.